Rule 506 (formally 17 CFR § 230.506) is a Securities and Exchange Commission (SEC) regulation that allows private placement under Regulation D and enables issuers to offer an unlimited amount in securities.
Relationship with Section 5 and 4(a)(2)
Generally, any security offering must comply with the Section 5 of Securities Act, which requires the issuer to file a registration statement. Section 4(a)(2), however, exempts “transactions by an issuer not involving any public offering,” i.e. a private placement, from the requirement to file a registration statement. If an issuer complies with the requirements of Rule 506 of Regulation D, then their offering will fall within Section 4(a)(2) and be considered a private placement. Congress additionally specifies in Section 4(b) that any sale under Rule 506 is not a public offering.
Requirements of Rule 506
While Rule 506 is one of the most common methods of private placement because there is no cap on how much the issuer can offer, the issuer must meet several restrictions:
- Securities may not be sold to more than 35 non-accredited investors. Any non-accredited investors must have sufficient knowledge in financial and business matters to be capable of evaluating an investment. The issuer must provide the non-accredited investors with certain disclosures, such as financial statements and be available to answer questions from non-accredited investors. The issuer may offer to an unlimited number of accredited investors, however, as defined in Rule 501(a) of Regulation D. Accredited investors are generally large financial institutions, such as investment banks, or high net-worth individuals.
- Rule 506 bans general solicitation of the securities. That is, issuers may not advertise their offering to a broad audience.
- Investors in a Rule 506 offering receive restricted securities, which means investors cannot freely resell their securities. To resell their securities, investors must file a registration statement or resell under an exemption. Rule 144 provides a common exemption to reselling restricted securities, most importantly by allowing resale if the investor holds the security for a certain duration of time.
[Last updated in January of 2022 by the Wex Definitions Team]
